September 2019 events in the U.S. repo market a closer look at the causes and impact

In September 2019, the U.S. repo market experienced a dramatic spike in overnight borrowing rates. The average rate for a 14-day repo operation soared to 10% on September 17, a significant increase from the previous day's rate of 2.1%.

The repo market is a critical component of the U.S. financial system, providing liquidity to banks and other financial institutions. It allows them to borrow and lend short-term funds, ensuring the smooth functioning of the economy.

The September 2019 events in the U.S. repo market were triggered by a combination of factors, including a decline in bank reserves and an unexpected surge in demand for cash. This led to a shortage of available funds, causing borrowing rates to skyrocket.

The Federal Reserve stepped in to alleviate the situation, injecting $75 billion into the repo market on September 17, and an additional $53.2 billion on September 19.

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The repo rate spike in September 2019 was a complex event with multiple contributing factors.

A confluence of factors caused the dramatic spike in repo rates, including large Treasury issuances, corporate tax deadlines, and an overall lower level of reserves.

The Treasury Department issued $78 billion of government debt that was due to settle on September 16, which led to a decline in the supply of cash available in the financial system.

Corporate tax payments for the third quarter of 2019 were also due on September 16, causing a decrease in the money market fund total assets by about $35 billion.

Aggregate bank reserves had declined to a multiyear low of less than $1.4 trillion by mid-September 2019, while net Treasury positions held by primary dealers had reached an all-time high.

The combination of these factors resulted in a large transfer of reserves from the financial market to the government, triggering a liquidity squeeze in repo markets.

The repo market segmentation and lack of price transparency among market segments also exacerbated the spike.

On September 16, repo rates began to rise in the Delivery-to-Payment (DVP) interdealer brokered market segment while the rates in the tri-party market segment remained relatively flat.

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The repo market segmentation and lack of price transparency played a significant role in exacerbating the spike in repo rates in September 2019.

Rates in different segments of the repo market were dispersed, with some segments experiencing rate increases while others remained relatively flat. For example, on September 16, rates began to rise in the Delivery-to-Payment (DVP) interdealer brokered market segment while rates in the tri-party market segment remained relatively flat.

This dispersion of rates suggests that some market participants were aware of the cash scarcity, while others were either unaware or unable to lend in response to the increased tightness. As a result, the lack of price transparency among market segments made it difficult for lenders and borrowers to determine fair prices for repo transactions.

The repo market is highly segmented, with different segments having different characteristics and requirements. For instance, the DVP market segment is interdealer brokered, while the tri-party market segment is more institutional in nature.

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The lack of price transparency in the repo market can lead to inefficiencies and distortions in the market, making it more difficult for lenders and borrowers to find each other and complete transactions. This can exacerbate market volatility and contribute to the spike in repo rates.

In the case of the 2019 repo market liquidity crunch, the dispersion of rates across segments and the lack of price transparency made it more challenging for the Federal Reserve to intervene effectively and stabilize the market.

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The Federal Reserve responded quickly to the September 2019 repo rate spike by introducing a cash injection through a repo facility.

This announcement helped alleviate the spike, with repo rates declining substantially in the DVP market segment.

The liquidity provided by the Federal Reserve also eased constraints on dealers, allowing them to move an additional $10 billion into the repo market.

The Fed's actions were a timely intervention, as the repo market froze in September 2019, with overnight repo rates trading 25 basis points higher than the norm on September 16.

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The overnight repo rate surged on the 17, with borrowers having to pay 3.00-3.50% more than was typical for a fully collateralized overnight loan.

The Fed provided immediate liquidity via an overnight repo operation, which was soon extended through the second quarter of 2020.

As a result of the Fed's actions, the amount borrowed from the Fed via this facility was about two times the peak borrowed during the financial crisis.

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The 2019 repo market liquidity crunch had a significant impact on the financial system, with the overnight repo rate surging 25 basis points higher than the norm on September 16.

Borrowers had to pay 3.00-3.50% more than was typical for a fully collateralized overnight loan, making it a costly proposition.

The Fed provided immediate liquidity via an overnight repo operation, which was soon extended through the second quarter of 2020.

The amount borrowed from the Fed via this facility was about two times the peak borrowed during the financial crisis.

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Investors with leveraged portfolios dependent on overnight repo had to pay dearly to borrow, some likely sold assets to reduce their funding needs.

The Fed came quickly to the rescue to prevent a liquidity-driven market meltdown, announcing $60 billion per month in Treasury Bill purchases (QE) and reducing the Fed Funds rate twice by the end of the year.

The Fed's actions helped to bolster liquidity in the system, preventing a more severe market downturn.